The lending trends within the ‘Big Four’ banks are disturbing

Things are – and have been for decades – changing among the “Big Four” banks. And policymakers should pay attention to what it means to the overall U.S. economy.

One of the advantages our economy has had over the years is that it is a large single market and has been for a long time, as compared to Europe, for example. A company making cars can sell them in every state (and therefore must compete with all of the other car makers selling their cars in every state). Until rather recently, however, banks were different because they had to operate in each state separately. In 1994, landmark legislation was passed (Riegle-Neal) that broke down the barriers to interstate banking, and in 1999 this was taken further by legislation (Gramm-Leach-Bliley) that allowed commercial and investment banks to combine. Thanks to the deregulation and economic growth of the 1990s, an extended period of bank consolidation has taken place with the four largest U.S. banks, JPMorgan Chase, Citibank, Bank of America and Wells Fargo, growing at an impressive pace of 14.8 percent a year from 2003 to 2008.

Then the financial crisis hit in late 2007, and an ensuing recession followed. During the crisis itself, federal banking and financial regulators and the Treasury encouraged three of the four large banks to take over other banks that were in financial trouble as a way of containing the effects of the crisis. JPMorgan took over Bear Stearns and Washington Mutual; Bank of America took over Countrywide and Merrill Lynch, and Wells Fargo took over Wachovia; Citibank did not make significant acquisitions. Given these sizable purchases one might reasonably expect that this meant the largest banks would grow even faster as a result of the crisis and they would hold a larger share of total bank assets. We set out to find if that did indeed happen – and it didn’t. The Big Four’s rate of growth dropped to 1.8 percent a year from 2009-2014 and their share of total assets actually declined slightly, from 52.5 percent in 2008 to 51.2 percent in 2014.

We also looked at changes in the composition of bank assets and liabilities. We found that the banks cut back on their reliance on short term wholesale funding, consistent with the direction of their regulators. And the banks experienced large increases in the volume of deposits they hold. Once the crisis occurred, though, the growth of loans dropped sharply relative to the amount of deposits. Because of a reluctance to lend, a lack of demand for loans, or some combination thereof, the intermediation process at banks – providing funding for investment and growth — has not been working in the same way as before the crisis. Our data also shows an unsurprising uptick in securitization business among the Big Four in the pre-crisis years, followed by a steadier post-crisis decline. This has been mirrored by changes in the composition of income among these banks. Securitization income as a share of total income has been on the decline since the crisis, while traditional income has remained relatively flat and nontraditional income has grown.

Prior to the crisis, these four banks reported profits of about 2 percent of assets and then they lost money in 2008. They have been able to return to profitability since then, however they have not returned to the pre-crisis level of return on assets, averaging a return of about 1 percent of assets in 2014. Of course, each of the Big Four banks has performed differently in this area. For example, Wells Fargo reported profits of about 2.5 percent of assets before the crisis and averaged a return of about 2 percent of assets in 2014. Citibank, on the other hand, reported profits of about 2 percent of assets before the crisis. That number plummeted to nearly -3 percent of assets during the crisis, and even in 2014 remains only at 1 percent of assets. Bank of America reported profits of about 2 percent of assets before the crisis; their returns on assets fell to 0 in the wake of the crisis, and only approached 1 percent of assets in the last two years. Compared to these banks, JPMorgan Chase reported relatively flat returns on assets over the past decade.

Although the deregulation and then the financial crisis caused the big four banks to increase their share of total banks assets and liabilities as a share of total banking, it is not by as much as previously believed and in fact, since 2010, the share of banking sector assets held by the Big Four banks has declined. This trend is likely to continue in light of regulatory pressure and capital requirements.

In many ways, it is too soon to know the ramifications these changes may have on the banking industry, which ultimately impacts the economy as a whole. However, our research shows a troubling decline in loans in relation to deposits, meaning banks have the ability to make loans but aren’t – either due to concerns about risk, or they may be restrained from lending by regulatory pressures. Loans are crucial to getting the economy to function and grow – the markets froze during the crisis due to fear, but was expected to increase as the economy recovered. That doesn’t seem to be happening as much as our economy needs. While further research is required on this and related issues, the trends reported in our paper may point to future pressure points in the financial sector.